I would argue the single most important decision you make about investing in syndications is not which deal to invest in, but which sponsors do you invest with. Obviously the deal itself is important – the numbers need to make sense and it needs to fit within your overall investment philosophy – however many investors focus on the deal exclusively and don’t pay enough attention to the sponsors.

The sponsors manage the investment and are ultimately responsible for its success or failure. If your sponsor is overly conservative, a deal that goes according to plan may not make as much money as it would with a more aggressive investor. On the other hand, if something goes wrong, the conservative sponsor might be in a better position to adapt and still provide reasonable returns to their LPs while the aggressive sponsor might end up losing money. Which type of sponsor is best for you depends on your strategy and risk tolerance. However, don’t be lulled into believing that the happy-case plan outlined on the pro forma is exactly what is going to happen – the real world rarely works that way. Over the past 3 years: interest rates doubled in the first 6 months of 2022; the pandemic shut down many “non-essential” retail stores for months; there was an eviction moratorium that meant that renters didn’t need to pay their rent for most of 2020 and 2021 (even longer in some locations); and supply chain and labor shortages increased the cost of renovations dramatically. No-one who was purchasing real estate in 2018 or 2019 expected any of these events in the next 5 years, much less all of them. However, as we start to see the short term (3-5 year) projects come up for sale or refinancing, some sponsors are in trouble as their exit strategies don’t have a lot of flexibility while others are still in a position to provide a solid return to their investors. While the deals may have started out similar, the positioning done by the sponsors as things changed made all of the difference.

Ultimately, successful real estate investing requires building strong relationships and I want to know as much about the sponsors and their history as I can before placing any funds. While we have all heard the saying “past performance is no indication of future behavior”, in this case, I believe the opposite is true: How people have behaved in the past is likely to be how they behave in the future. So I talk to the sponsors to understand their history, and how they align with the traits I care about. I try to understand the answers to questions like: What lessons did they learn from the market in 2008-9 and how are they incorporating those lessons into their decisions today? How many deals have they done in this asset class, and in this location, before? How did those deals turn out? What did they learn from them? Can they provide an example of a deal that hasn’t gone to plan? How did they protect the investors? What was the final outcome? What did they learn and how are they applying those lessons today? How are they communicating with their current LPs? This typically spans multiple conversations, and isn’t meant to be a hard-hitting interview, but over time I can usually get the answers to these questions while also finding out the things that they feel are important about their company, plans, and goals. Not everyone will have perfect answers to these questions, but having this conversation gives me a way to build a relationship with them and understand whether or not their approach to their investors aligns with what I am looking for. I want them to be open about problems they have had and how they were dealt with, and I want them to have learnt from those experiences and incorporate those lessons into how they operate today. It is ok to have failed, we all have, it isn’t ok not to learn from those failures and instead repeat the same mistakes over and over again. And it isn’t ok to gloss over things and not be transparent about problems you have encountered, especially when the problem impacted your LPs.

In addition to finding a sponsor that I believe I can build a strong relationship with over time, I look for a few key traits (note: the GP team needs to have these traits, not necessarily a single person):

Experience dealing with a recession. I know we haven’t had a major market downturn in a while (current market notwithstanding) but markets are cyclical and I want someone who has been around long enough to have learned the lessons from a difficult market. In the past few years, almost anyone investing in real estate was able to make money because the market was strong enough to cover mistakes. I want a sponsor who knows how to adjust plans to keep making money when the market turns, and that knowledge typically comes from experience and hard lessons learnt. Because it has been 15 years since our last major down market (2008) that means that I don’t typically invest with sponsors who have only been investing 5-10 years. There are enough people who were investing 15 years ago, and still are, that I haven’t found this to be a major limitation. Once caveat on my philosophy here, I don’t necessarily require someone who to be investing the same way as they were doing in 2008 (people and circumstances change over time) but I want someone who was aware enough of the environment at the time that they were able to internalize the lessons from then (e.g. markets don’t always go up, loans aren’t always at 3%, rents don’t always increase at 10%+/yr) and use that experience when making decisions about their business now. This experience can be reflected in a lot of ways. For example, the asset classes they are most interested in, the amount of debt they are willing to take on, the cap rates they expect on sale, how they budget for expenses, and whether they structure the deal to obtain positive cash flow from the start or only after a certain amount of time to complete a value add.

Experience with the asset class being purchased. This might be obvious, but I don’t want to be investing in the first deal that the sponsors have done in a particular asset class or market segment. There are big differences between multi-family, storage units, and warehouses for example. Similarly, the market in NYC is very different than the market in KC. I want someone who is an expert in the specific niche being purchased in order to understand the nuances of the deal. This is important since those nuances can often make or break a deal, especially when there is a value-add opportunity. Everyone starts with their first deal, but unless there is at least someone on the team who has this experience, I will usually pass on the deal. That also means that I will usually pass on the first deal from an established sponsor when they move into a new niche.

Experience with setting up straightforward syndications. Syndications are different than general partnerships and have a level of complexity that can be intimidating. I want the team to have been down this road before so they understand the expectations that LPs have as far as both returns and fees and structure the syndication in a way that makes things as clear as possible. I want them to get most of their income when the deal is wildly successful, as opposed to through fees that are collected even when the deal doesn’t perform. I have seen experienced sponsors put together hugely complex PPMs, where the overall structure was confusing and it wasn’t clear how money was flowing, what the fees were, or why the structure needed to be that complicated. I have seen other sponsors put together overly complicated waterfall models that ended up unintentionally (?) reducing their fees while trying to accommodate too many special case scenarios. The deal should be as simple as possible, and no simpler, and the sponsor should not only understand why anything that makes the deal complicated is required but be able to explain it to the LPs. If the sponsors have a history of putting together overly complicated syndications, then I move on to others since it is unlikely I will invest in their deals going forward and prefer to focus my time on sponsors where there is likely more synergy.

A stellar reputation in the community. I am sure you have heard that real estate is a relationships business. That is particularly true for syndications. The number of syndicators in a niche is not that large, and once you start to associate with one or two GPs, it is relatively easy to find others as you become part of the community. As you get to know people better, you find out who they respect in the area and these are often the people you want to work with. Finding that initial set of contacts requires engaging in the community – there are many people who tend to appear as speakers at events and guests on podcasts, so that is a good place to start. While it is easy to think that the best syndicators are the ones that are the easiest to find, that isn’t always the case. It really depends on their personality and how they view their business. Some are extroverts who want to be well known and take every chance to promote themselves and their next deals. However, others are much more conservative and don’t spend as much time promoting themselves, or use less public forums, but still have an outstanding reputation in their area. By becoming part of the community, you can find out who those highly respected people are even if they aren’t on stage. It is worth calling out that the more established and respected a sponsor is, the easier time they have raising money. As a result, the terms of their deals may not be as good as the terms that you can find with someone just getting started, who needs to offer better terms to attract investors. From my perspective, a reasonable experience premium is worth paying since it increases the chances that the deal will be successful.

Strong communication skills. Few things are more nerve wracking than sending someone a huge check and then not hearing from them for 6+ months. I want my sponsors to keep me informed of how things are going. I don’t want them to just confirm that they got my check (surprisingly not always done), but provide regular (quarterly at least) updates as far as how is the asset performing, what went well, what didn’t go well, and what the next steps are. I may be a silent partner, but I am still a partner and want to be informed about the status of the investment. This is particularly important when things are not going to plan. If there is trouble, I want to understand what the problem is, how the sponsor is trying to address the problems, and what the likely outcomes are. That gives me time to adjust expectations and resources on my end. To determine their specific style, I ask for information about what they have done in previous syndications: are they sending out quarterly newsletters? Hosting webinars? Making phone calls when things are not going to plan? Or are they silent and assuming that LPs don’t need to know anything? I also pay close attention to how fast they respond during our initial discussions and answering questions I have as we move through the process. If they don’t meet my expectations at the start, I will move on to other opportunities as they are never going to be more interested in talking to me than when they are trying to get my money. I have had GPs contact me to invest in their deal and send me the PPM, but then never get back to me when I asked questions about the specifics of the deal and the structure they had set up, even after follow ups. Obviously, these aren’t people I expect to be responsive after I have given them the money so I appreciate that they clearly indicated their style up front.

Flexible communication strategies. Ensuring our preferred communication mechanisms align is important to me since this can reduce the potential for misunderstandings and stress in the relationship. Because I live in Hawaii and have a day job, the time that I spend working on my investments is generally “off hours” from a normal schedule. As a result, I really value the ability to communicate asynchronously most of the time – I want to be able to send an email late at night (on the east coast) or over the weekend and get a response back the next business day or two. Of course, there are some questions or issues that are best handled over the phone, and for those having a simple mechanism – like calendly – to help schedule calls is an important additional capability. I find it challenging to work with sponsors who insist on picking up the phone and calling me in the middle of their day to answer simple questions, since I can’t usually answer and we end up playing phone tag. They are trying to be responsive, but it turns out to be disruptive and tends not to work well for either of us. Of course, having someone responsive but using a different modality that I prefer is much better than someone who is completely uncommunicative –so I appreciate their efforts but try to get them to use email when possible.

As you can tell, I have a strong preference for well established syndicators with a strong track record. However, other investors may prefer newer GPs as they would typically get better terms on the deal, like getting in on the ground floor of someone’s career as it takes off, feel that they can safely help someone get started in their role as sponsor, or know the sponsor personally. Those are all great reasons to do the exact opposite of what I do. And that’s ok. A recurring theme throughout this blog, and life in general, is there is no single path to success. The most important thing is to understand why you are making the choices that you are making and that they are informed choices. As long as they are the right choices for you, at this time, that is what matters.

Once I have completed my initial discussions, and decide that the sponsor passes my review, I like to do a small investment with them first – usually at their minimum investment level. This gives me a chance to see if my initial impressions were correct and if they follow through in the ways that I expect them to. To be clear, I don’t wait until the initial deal completes full cycle – which can take 5 or more years – to make my assessment but I do typically wait six months to a year to get confirmation of their behavior post-deal.   Once I have confidence in them and have more evidence that things are going as I expect them to, then I invest more heavily in future deals. I really appreciate it when I find a sponsor that I align with since all I need to focus on going forward is the deal.

If you have any questions about this post, please email them to me at terence@mbc-rei.com, I will reply to the questions that are straightforward and will turn the questions requiring more detailed answers into future blog posts